Mark Thomas'  Instablog

I'm constantly amazed at the The Stock Trading Coach.com inordinate amount of time the financial media devotes to discussing the stock of Apple Inc. (AAPL). I understand why since it was the biggest wealth generator of this bull market when it was over $700 and it is one of the widest owned stocks it has been it deserves much attention. The subsequent 45% decline from over $700 to $393 recently erasing hundreds of billions if shareholder value is definitely one of the biggest news stories and deserves huge coverage. What irritates me is the endless question almost always being asked is; Is Apple finally a buy at the $650 price level, then $600, $500 price and then finally recently at under $400. With almost any other stock that just got dramatically ahead of its fundamentals, became overpriced and finally got to the point where there was no one left to buy it. At that point the stock begins a long decline and most investors become more rationale when such a massive growth stock reverses and the momentum shifts to the downside. Apple though has been different than almost any stock I have seen in my twenty plus year career in that investors are almost incapable of being objective about the stock. The reasons are numerous but I think it is because number one, so many people have memories of their previous spectacular gains in the stock it clouds their present judgment. The second reason clouding their objectivity is they use all their products and think just because others like themselves are locked into their "ecosystem", they always will have the same pricing power and profit margins going forward.

I have bad news for the value investors who want to buy Apple for a longer-term hold. While it might be a stock that is still able to be bought at extreme selling panics and then sold for a 5-10% subsequent gain short-term, buying it hoping the stock will make a 20-25% move back to $500-525 in my opinion is a fool's game. The reason is very simple; the company is overwhelmingly dependent on the IPhone for its profits and margins. Yes they make money in tablets and some other products but they get about 65% of profits from the IPhone. The fact is they have smartphone profit margins of about 40% vs. Samsung 25% profit margins. Since their product is now no longer the leader, their market share and their profit margins will continue to fall, not rise. That is why there gross margins have declined for four quarters now and will continue too. Not only will they continue to fall but as you can see by the wide difference of 15%, they probably will continue to fall substantially, not incrementally.

That is why the company has finally reversed itself so dramatically and announced a large dividend increase and a massive stock buyback. You would be surprised to find out that it is very important that Apple keeps it stock price up because they still use options to supplement compensation to make it appear they are more profitable than in reality they are. This is common in technology companies and most buybacks in the sector are just a sham designed to offset dilution from exercising stock options. It basically is masking their true operating expenses for labor for accounting purposes and is legal but for the most profitable company on earth is petty. I think the company also finally came to the realization that without massive buybacks, their earnings would decline substantially.

I'm neither long nor short the stock and that is one reason why I can actually be more objective. My main point about the stock for an institutional investor or a longer-term value investor is they should look at more than the basics that make it seem like a company trading at under ten times earnings with a balance sheet that screams buy at these levels. The stock will probably still produce good trading opportunities for more nimble traders but for a mutual fund who makes decisions in days or weeks there are probably better opportunities. As a value investor when company fundamentals are in decline, you must wait for time when the value offered is so overwhelming and the negative sentiment is so extreme, like Hewlett Packard or Intel last December or your value investing can be very difficult and frustrating.

Tip #1: Managing your stock or investment portfolio is like tending a garden.

With your stock portfolio you need to treat it like a garden. You want to water the vegetables and pull out the weeds! This is another very simple concept. You want to sell or remove the weeds which are stocks that are losing money or aren't performing as planned. Losses are like weeds, once they take hold they drain resources and multiply rapidly. Your vegetables are your profitable stocks. You want to nourish them with fertilizer and attention. Like vegetables you also have to harvest them or if you wait too long (get greedy) they will take back what they have produced. By removing the weeds (minimizing losses) you also free up new ground for better ideas with potential of producing good fruit. The weeds also sap your attention and resources that can be devoted to your productive vegetables. This is a constant process and if you approach it that way, you're already trading and investing like a professional does. Many people do the exact opposite! They sell their winners too soon and hold onto their losers in hopes their weeds will mutate into a vegetable. Hope is not an investment strategy and it is a losing one, so don't do it!

Tip #2: Supply and Demand for shares is what determines the direction of stock prices.

You have to understand that the real forces which set stock prices in the very short-term are supply and demand just like with any other product. If the demand for a company's stock exceeds willing sellers at the current price, the price will move higher to induce additional sellers. If there is insufficient demand at the current price, the price will move lower in order to induce additional buyers. The stock market in this sense is just that, a market of buyers and sellers who come together and agree on prices. If you just understand this simple concept you have an advantage over other investors. They think there are other more mysterious forces at work when in reality that is what governs prices in the very short-term. The financial media adds to this because every day they try to report a reason or news item for why the market went up or down. This is a reason that emotions affect the volatility of the trading of stock prices. If you understand this concept it also gives you a much better understanding to have better insight from technical analysis which I will talk more about later.

Tip #3: Some of the best investments and trades of my career were totally obvious if others had paid better attention.

For instance I usually never trade or invest in technology stocks but when the IPAD was introduced by Apple I immediately knew I might have a winner. The media derided the product as one that really didn't have a purpose and female reporters mocked the product because the name reminded them of a feminine hygiene product. I watched the over hour long Apple presentation about the product and was astonished. I watched it two more times and immediately knew apple had another hit like the IPod and IPhone. I then looked at the company's fundamentals and found it very attractive. They had no debt, $60 billion in cash and marketable securities. They traded at only ten times earnings when earnings were growing at 30% plus. Unlike most technology stocks that trade at four or five time's revenue, they were trading at 2.25. I figured a company like this was worth three times revenue so with the stock trading at $210, I thought it could be worth $275. As we know now the stock eventually traded over $700, so this proves that one of the most obvious trades around was sitting there undervalued and unappreciated for months at a time. This was one of the few times in my entire career I bought a technology stock and while it paid off handsomely, I will admit I misplayed one of the best opportunities of my entire career.

At my stock trading alerts email service TheStreetEdge.com, I'm always looking for situations where I can have an informational advantage over other investors due to negative perceptions and herd like thinking. I have been watching Intel (INTC) for months now, waiting to purchase it. I have been waiting as the negative consensus around the stock has built to a crescendo. As a very short-term investor I'm not usually attracted to value stocks that might take a couple months to turn around, even more so if the stock is in the technology sector which I have avoided almost my entire career. However in the last few years a trend has been working against a household name blue chip stock that has driven down the price of the stock to very, very attractive levels. The performance of the stock has been so bad, that literally right now no hedge or institutional investor wants it to show in their portfolio at year end, except for the true bravest longer-term contrarian value investors. Intel's stock right now is literally inside the bargain bin.

I will tell you about the financials of the company and then I want you to ask yourself, if that was all you knew about the company: would you buy the stock? The company is one of the world's largest corporations. It dominates its market like few ever have in world history, especially in the ever changing world of technology. It has a quarterly dividend yield of 4.25% or 240% more than the current 10 year US Treasury yield of 1.8%. It trades at only eleven times future earnings or 12% below the average stock in the S+P 500 multiple of 12.5. The company is so financially solid; it just borrowed six billion dollars for an average interest rate of only 2.72% for over fifteen years. The company already had $3.25 billion in net cash on the balance sheet equivalent to $.75 cents per share which equals almost 4% of the company's market capitalization. After this new borrowing they, have $9.25 billion in cash or the equivalent of 9% of their market capitalization. It is pretty obvious they intend to pay a special dividend or fund a very large stock buyback which could reduce shares outstanding by almost 5% over time.

Now I know what you're thinking, here we go again. This person is suggesting you consider buying Hewlett Packard (HPQ) or Dell (DELL), companies that are past their growth stages, now stagnant, in decline or in serious trouble. There goes some Wall Street guy who says buy this technology "value stock" that winds up being a "value trap" for your hard earned money. However sometimes you can find a diamond in the rough and that is what I'm talking about today. Before I tell you the stock, ask yourself; if this is all you knew about the stock, would you buy it? My answer to that question is that if the business isn't in a serious decline and that I thought the management could adapt or overcome its current troubles; yes I would buy it and buy it pretty aggressively. That is what I just did with Intel (INTC) making it one of my largest stock positions here at the end of 2012 and going into 2013.

Of course when you're offered merchandise at a discount like this, there has to be something wrong with the company or other investors would not have such a negative consensus about the stock. I'm not saying the company isn't facing serious challenges in its core business. However I'm saying that at current prices those fears are clearly overblown and the price has more than overreacted to the business challenges and the valuation of the company is substantially below where it should be. I like investments with a very simple investment thesis to focus on. In this case it is that Intel got sloppy and has fallen behind in the growth areas of making chips for smartphones and tablets. Smartphones and tablets are where all the growth is in number of units sold. For a company like Intel who dominates 85% of the worlds' personal computer market, this is a position they aren't used to. One of the reasons this occurred is in mobile devices, the amount of power used is much more important. A company called Arm Holdings (ARMH) focused on a line of chips with less power usage and now they are very big in the smartphone sector. The other big beneficiary of this trend had been Qulacomm (QCOM) as they profit from a licensing fee from about 90% of the chips used by the largest sellers of higher end smartphones.

What I just outlined is widely known and is now just accepted as a general consensus fact and that negative consensus is what creates the price opportunity in the stock. Now the consensus expectations going forward are so low and the price of the stock has come down so much, it is a bargain. In fact I think it is a wonderful stocking stuffer to buy for yourself or a family member. The first thing you have going for you by buying the stock is a 4.25% dividend yield. It is only eleven times my 2013 earnings estimate of $ 1.90. More importantly ay an enterprise value of only $110 billion, it is only 2.0 times annual revenue of $53 billion. By my estimate Intel's stock is worth at least 2.5 times annual revenue which would equal $26.50 which would be a gain of 25% from current prices. That is my 2013 price target but for now I like the stock going into 2013 as a beaten down blue chip stock where the expectations and price are so low, it should get some lift over the next one to two months. Technology stocks like this used to trade at three times revenue but I don't think Intel will probably ever achieve that high of valuation again. The only thing you have to believe is that Intel that has been around the longest, has the most talented people in the business and a new CEO to become positioned in mobile and tablets. It has paid to bet against Intel short-term all thru 2012 but now the time has come to bet on Intel to rise again.

Disclosure: I am long INTC.

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